Littlewood responds to Cullens claims on superannuation

Monday, August 27th 2001, 4:49PM

Littlewood responds

The New Zealand Superannuation Bill is two
thirds of the way through its passage through the House and the
debate is heating up.

Today I would like to take some time going
through the Bill with you and talking through some of the more
outrageous claims and myths that have grown up around the Bill
over the past year. I can then answer any questions you may have
at the end of the session.

My colleague Steve has handouts of this
presentation and they will be made available for you.

It is a simple fact that New Zealand's population
is ageing. Now 12 percent of us is aged 65 or over. Within the
next 50 years, that ratio will have risen to 25 percent.

Not only will the proportion of retired
people to workers increase but, as life expectancies continue
to grow, the average period spent in retirement will also increase.
This is a myth or, at
least, it is not the fact that the Minister would have us believe.
The average period in retirement is certainly influenced by mortality
but is also significantly affected by the retirement age. The
Minister assumes that today's average "retirement age"
(and we really have no idea what that is) will stay at today's
level. What evidence does the Minister have for his assumption?
On what basis does he make the projection that today's behaviour
will persist? Why, for example wouldn't tomorrow's want to retire
later (especially if New Zealand Superannuation were increased
for late retirement)?

The cost of providing New Zealand Superannuation
will make a much bigger claim on the public purse in the future
than it does now. That
assumes maintenance of current terms and continuation of current
retirement patterns. Now it commands
about 4 percent of all activity in the economy. By 2050, it will
command around 9 percent. And,
on the same guesses, will top 10% by 2100. So will health spending
which will follow a similar age-related pattern.

Basically there are only two ways to reduce
this burden: either cut the pension or smooth the costs of it
by putting money aside now. And,
on the same argument, there are only two ways to deal with the
future cost of health care - cut future health benefits or smooth
the cost by putting aside money now. Having begged all the important
questions on retirement income provision (retirement preferences
and patterns; appropriateness of current state provision etc),
the Minister now expresses the issue on a basis that he knows
will push political buttons. It doesn't, however, help the debate,
if that's what he wants to happen.

National's intention is to cut the pension.
You may not know that because they are not very honest about it.
They don't shout it from the rooftops. Instead they talk very
softly about how they will not cut entitlements for current retirees
and say nothing about their longer-term plans. And neither can the government, given its refusal
to discuss the important issues. The Minister restates the myth
that, in creating the Big Cullen Fund, the government has resolved
the issue of cost. The government has not done that (more on
this below) so the basis of its criticism of National is misstatement
founded on myth. But then, what's new in this debate?

They have a faultline running right through
their policy which is why they need two spokespeople. Bill English
talks for the future retired. Someone else altogether talks for
the currently retired. They have two tongues on super' because
they are two-tongued on super'. Oh dear. While this sort of stuff may be amusing
in the bear pit of the debating chamber, it's less than helpful
here, particularly for this audience (Grey Power) that hasn't
been known for its even-handed views on some issues. It's the
Minister's typical ad hominem debating style.

The Labour Alliance Government starts from
the premise that a society should be judged on how it treats both
its youngest citizens and its old. That is one way of judging a society but it begs
a question or three. Another way of judging a society is by economic
growth, or by its standard of education. Both of these would
allow governments the resources to treat its youngest and oldest
citizens in the ways this government would prefer. No prizes
for guessing which is the more important. Governments may dispose
of wealth but they don't create it.

The entitlements contained in Part One of
the New Zealand Superannuation Bill now before the House are,
we believe, the minimum necessary to allow superannuitants an
adequate standard of living and the opportunity to participate
in their community. On
what basis? Where is the evidence? A recent survey shows that
retirees seem reasonably contented with their lot but that would
probably be the case if NZ Super were 10-20% more or 10-20% less.
I don't know that, of course, but neither does the Minister.

National had reduced the wage floor from
65 percent to 60 percent of the average, after tax, ordinary time
weekly wage. That was
a silly thing for National to do and the way it went about it
was even sillier. We have taken it
back to 65 percent. Without
asking why it's that number or whether some other number (or numbers)
might do just as well.

But it is important to remember that the
65 percent is calculated for the married rate. A single pensioner
gets around 60 percent of that, or around 40 percent of the average
wage. The point being?

You cannot cut that without forcing some people
into hardship and this Government will not do that, especially
as almost half of this generation of retirees depend on the pension
as their only source of income. Alternative
ways of ordering things (like a more generous pension [say, 80%]
but income tested) would make people in hardship better off and
could also lower costs. Where is the debate? The consideration
of different ways of doing things? This is an idea-free zone.
And frankly, there is no reason to
expect that ratio will change significantly in the next few years.
I agree but the NZ
Superannuation Fund has nothing to do with pensions for the current
retirees. In fact, it has nothing to do with future retirees
either for reasons I will identify shortly.

So Labour and the Alliance explicitly reject
National's cost-cutting agenda. This is a straw man argument.
The Government acted with integrity in, having committed ourselves
to maintaining the pension at current entitlements; we then found
a mechanism to pay for that commitment. No way, José. At the most, the NZ Super
Fund will contribute no more than 15% of the cost of any year's
NZ Super. And, when the Fund is completely spent by 2100, the
net cost of NZ Super will be 2½ times what it is today
and 11% higher than it is expected to be in about 2050 (the peak
draw down period). So tomorrow's taxpayers will be left with the
issues that today's government refuses to discuss. I guess that's
politics. It doesn't make it sensible.

The proposed New Zealand Superannuation
Fund does that. Anyone
who believes that is, in Rob Muldoon's words, a believer in the
tooth fairies. Our political opponents
- and particularly Mr English - attack the plan constantly not
because they think it will fail but because they are scared it
will succeed. They simply cannot allow the Labour-Alliance coalition
to pull off an achievement of that size.

The Treasury has done excellent work in
designing the structure and governance arrangements for the Fund.
But does the Treasury
support it? I suspect it does not.
These are incorporated in Part Two of the Bill and were recently
described by a leading international expert in superannuation
funds are "a world-class solution." Source?

Let me now go through the Bill in some detail.

The New Zealand Superannuation Bill is in
three parts:

Part 1 covers existing NZS entitlements,

Part 2 deals with arrangements for establishing
the New Zealand Superannuation Fund and

Part 3 covers the processes for political
sign up to the legislation and making changes to the legislation.

No change to current entitlements
There will be no change to current New Zealand Superannuation
entitlements. By this
the Minister means no present change. He has already said that
a government of the 2020s may need to think about raising the
state pension age - presently 65. This is what he actually said
on this:

"We recognise
that changes in life expectancy and medical science may lead
some future government to consider raising the age above 65 but
would expect that any such review would be 25-30 years away."

In the Minister's own words,
the government is being "two tongued". Raising the
age is just as much a cut to NZS as any dastardly alternative
that the wicked Tories may be cooking up.

Existing legislation relating to NZS entitlements
has been taken out of the Social Welfare Transitional Provisions
Act and placed alongside the funding elements in the New Zealand
Superannuation Bill.
This transfer has been used as an opportunity to correct some
drafting in the old legislation. The wage-floor of NZS has been
set in the legislation at 65% of the average wage.

The drafting of the Living Alone rate of
NZS has also been clarified:

Superannuitants who are living alone receive
a higher rate of payment than superannuitants who are married
or are sharing accommodation. Originally this was provided in
the form of a 'living alone payment' but this was subsequently
incorporated into the Living Alone Rate

In previous drafting there were in effect
two 'entry points' to receiving the living alone rate- the rate
set out in the first schedule of the Act and the criteria for
receiving the living alone payment.

In the Bill it is clear that the criteria
for receiving the living alone rate are the appropriate entry
point to the rate.
Part of the eligibility criteria for the Living Alone rate is
that a pensioner must be resident in one of a number of specified
types of accommodation. These accommodation types are listed in
the legislation. In previous drafting it was unclear that the
list is intended to be exclusive, and not a set of examples. This
has also been clarified.

This is all rats and mice
stuff alongside the really important issues.

Key Elements of Fund Design
Part 2 of the Act establishes the New Zealand Superannuation Fund
and sets out how it will be financed.
The key elements of the design of the fund are that:

There is a transparent process for determining
the contribution required for the fund

The contribution to the fund will be
based on a legislated formula with a long time horizon

The board of the fund will have independence
from government in determining its investment strategy and processes

The board will be required to meet commercial
investment objectives

The fund will smooth the increase in the
cost of New Zealand Superannuation over time

Transparent Annual Funding Process
The contribution to the fund will be assessed annually as part
of the Budget process. And Treasury will calculate the rate that
is required.

The contribution is calculated by determining
the costs over a forty year period and making an annual contribution
into a New Zealand Superannuation Fund that would be sufficient
to meet costs for 40 years, if it was applied in each of those
40 years but will not
exceed an estimated 15% of any year's costs when the draw down
from the Fund is at its peak. The other 85% of each year's costs
will be met from that year's tax take, as now.

Contributions will be determined as a
percentage of GDP.

Each year, the rate will be recalculated
and will exclude the past year and include the next year 40 years
in the future. In this way it will be calculated on a 40 year
rolling horizon.

Independent Governance

There will be "double arm's-length"
between Minister and Fund. This
overstates the "Guardians'" independence. Apart from
the fact that the government will be making the appointments,
the Minister has made the position of "independence"
clearer elsewhere:

"Because the Board
will be independent from the Crown, it will be required to have
regard to rather than give effect to directions from the government."
(his emphasis)

"Double arm's-length" is polly-speak for "not
under day to day control".

Prudent commercial management, and consistent
with "avoiding prejudice to New Zealand's reputation as
a responsible member of the world community." That was an attempt to satisfy
the Greens. Given that they have now voted against the Fund,
what do these weasel words actually mean or add?

Minister appoints from a shortlist prepared
by a nominating committee. More
jobs for the faithful.

Investment Objectives
The board will set its investment strategy in the context of the
investment objectives set out in the Act. The Fund is to be managed
on a prudent commercial basis.

While the board will set the investment
strategy, it is anticipated that it will do so on the basis of
best practice portfolio management.

The board must be mindful of risk in determining
its investment strategy and any impacts its investments may have
on New Zealand's reputation as a responsible member of the world
community.

The Fund is to be used to meet NZS payments
only. It will not be used to meet other government objectives.
Yes but those other
objectives can be met or not from reduced expenditure on New Zealand
Superannuation and a greater draw down on the Fund. Again, the
Minister overstates the position, the genesis of yet another myth.

Smoothed Pay-As-You-Go Funding
We currently have what is called a "pay as you go" system,
where NZS is paid out of the Government's current tax receipts.
The form of pre-funding we are considering is "smoothed pay
as you go". This will involve creating an investment fund
that will accumulate and invest funds. These funds will be drawn
on to augment the "pay as you go" system to pay NZS
as costs increase in the future. And they will continue to increase even allowing
for the draw downs - more on the issue of "cost" in
a moment.

Now, let me deal with some of the criticisms
of the Fund and the myths that have arisen in recent months.
Opponents of the Fund raise two criticisms. They say the Fund
will only ever supply around 14 percent of New Zealand Super costs.
In fact the total share will be closer to 25 percent.

They are counting only the amount which
will be directly drawn from the Fund. They are forgetting the
further - substantial - revenue stream the Government will receive
through the taxes paid on the Fund's earnings. The Minister is disingenuous. He either doesn't
understand the issue or is deliberately misleading. The Fund
is able to put money aside only because the government has to
collect more taxes from New Zealanders than they would otherwise
have paid (in the absence of the Fund). That is what a surplus
is. Too much tax collected. So, the question the Minister leaves
unasked and therefore unanswered is what would have happened to
those taxes had the government not collected them?

New Zealanders might have
spent the taxes that they wouldn't have paid (GST collected; vendors
of products and services pay taxes on extra profits; economy grows
in those places where the money is spent). They might have invested
the uncollected taxes either in financial investments (income
tax on investment income), or in their business (economic growth,
more taxes) or in paying off debt or getting an education (higher
earning prospects, more income taxes in the future). The Minister
should ask the Treasury to do a full analysis of these issues.
He hasn't or, if he has, he hasn't released the results.

We have never claimed the Fund would fully
meet Super costs and have always been careful for this reason
to describe it as a partial pre-funding scheme. But a 25 percent
contribution is a lot better than nothing. And 14% (the maximum "real" contribution
expected by the Treasury) is a lot less. Almost trivial, relatively
speaking despite the huge sums involved.
Without it, a future government would have to cut spending, raise
taxes or opt for a combination of the two. No mention of the risks that the government (also
known as "all us taxpayers") runs with this approach.

As to the larger debt issue, this Government's
objective is to keep net debt below 20 percent of GDP and the
budget has us achieving that with room to spare while we simultaneously
put savings into the Fund. What
is the magic of 20%? Why not nothing? Or 40%? Have we had a
debate about that?

The second criticism can be just as easily
dismissed. Political opponents argue that, because the dollar
level of government debt is rising, the government is borrowing
to pay into the New Zealand Superannuation Fund. That is nonsense.

I have always said that the contributions
to the Fund will come from the operating balance and the latest
budget shows this is achievable. It has operating surpluses of
$1.4 billion in fiscal 2002, and $2.4 billion, $3.1 billion and
$3.7 billion in subsequent years.

These forecasts are fully adequate to, indeed
they are 72 percent above on average, projected transfers into
the Fund of $600 million in 2002, and $1.2 billion, $1.8 billion
and $2.5 billion in the years following.

This is a fiscal word game,
as the Minister knows and the Opposition has already pointed out.
In nominal dollars, debt will rise at about the same rate as
the contributions to the fund over the next four years. If the
contributions were not needed for the Big Cullen Fund, debt would
not need to rise by that amount. It's really quite simple stuff.

Let me finish with a little myth busting:

MYTH: The Fund will be monstrously
large
The purpose of the Fund is to partially smooth out the cost of NZS to the rest (? - what is the "rest"?) of the Crown over time. The cost of NZS now is
less than its expected cost in the future, so the Fund builds
up and is drawn back down as the Crown adjusts to the higher ongoing
cost of NZS later this century. No
- the cost of any superannuation scheme - state or private; defined
benefit or defined contribution; funded or "pay as you go";
pension or lump sum - is the benefits paid. That will always
be the case regardless of where the money comes from.

The government refuses to
countenance any debate about the benefit design of New Zealand
Superannuation and so the government has fixed the cost of NZS
(for now at least).

What the Minister is actually
talking about is the incidence of that cost. That may sound like
a small point. It is not and the Minister's statement shows how
little he knows about this subject or how little he is saying.

The single year's cost for
any year in the next 100 years (the lifetime of the Big Cullen
Fund) must be drawn from the economy of the day whether that means
from taxpayers of the day or from investors of the day who have
to buy the investments that the Big Cullen Fund will be selling
or from lenders of money to the government. There are no other
sources of money. Whichever way, it will be the economy of the
day (not of today) that re-adjusts to the impact of that year's
full cost of NZS.

At its peak, the Fund is expected to grow
to about 50% of New Zealand's GDP. This expected level of the
Fund is fairly robust. Meaning?
If the key drivers are calculated largely as percentages of GDP,
we shouldn't expect any other result.

If you lower assumptions about expected
rate of return, a higher capital contribution is required so these
even out in the expected Fund level. However, with decades of
compounding actual returns, reasonably wide confidence intervals
need to be placed around this expected level, perhaps in the range
of 30% to 70% of GDP. There is not a target level for the Fund;
its level is just a consequence of smoothing the cost over a forty-year
rolling-horizon. So,
where is the argument about the consequences of this "monstrously
large" fund? It will be by far the largest single pool of
investment assets in the country. For example, it will be larger
than the whole of the New Zealand share market is today. It will
totally dominate the New Zealand investment scene - why else have
fund managers been so silent about what a daft idea the Minister's
Fund is? No one can blame them for that (they have their shareholders
to think of) but it illustrates the huge impact this "monstrously
large" fund will have in a miniscule capital market.

The Minister has given not
the sniff of an indication that he is aware of the reasons that
others are concerned about this.

MYTH: It is better to pay off debt
This myth sees paying off Crown debt as an equivalent form of
public saving that could be used to achieve the same ends of building
a more robust Crown financial position to help cope with the increasing
demands expected on the public purse later this century.

If the planned savings in the Fund were
instead put to paying off debt, net debt would be down to zero
before the end of this decade and so it is only a few years until
the issue would need to be faced of how to best govern a growing
pool of financial assets.

Debt is already down to comfortable levels.
Paying down debt is no longer the fiscal imperative it has been
in the past. Without a formal process to increase public saving,
Budget demands will mean that net debt is unlikely to improve.

The Minister slides past
the wider point that any contribution paid into the Fund (whether
out of a "real" surplus or not; whether current levels
of debt are "comfortable" or not) and in the presence
of any debt at all is the same as borrowing to invest.

Borrowing to invest is a
risky business - would the Minister raise a mortgage on his own
home and put the proceeds into international share markets? I
don't think so. Well, he shouldn't be doing that for the country.
In this case, the arguments that should counsel an individual
investor against such a risky approach apply also to the country.

If the Minister is really
worried about his seemingly profligate fellow ministers then my
point will be covered if the first ten years' contributions (roughly)
were entirely invested by the Big Cullen Fund in New Zealand government
debt. But that would then expose the Fund to the charge that
it's really a smoke and mirrors exercise which it really is.

Finally, let's look at what's to stop
future government's raiding the Fund.
The law will require governments to make sufficient annual contributions
to the Fund to meet the annual costs of NZS for at least the next
20 years. Translation
- what currently comes entirely out of the government's general
funds will now be passed through the Fund and only a fraction
will be left behind. The Fund will gradually
build up during this time, and its size will be the best indicator
of the security of future NZS. Any government that tried to raid
the pensions of the next generation would suffer at the court
of public opinion.

The experience of successful schemes overseas
is that consensus developed, not before, but after the scheme
was established. Evidence?
Is this the government's justification for refusing to engage
in a proper debate about any of the principles and then failing
to gain the support of parliament without some sort of a deal
(unannounced) being done with New Zealand First to squeeze more
than 60 votes from MPs. Again, as the
fund built, people began to derive a sense of security from it
and were anxious to see it protected and maintained.

I am confident that will also be the case
in New Zealand and that - finally - we will have succeeded in
putting superannuation above the political game. The Minister could not be more wrong
about this as time will tell. Rob Muldoon thought he had "put
superannuation above the political game" with National Superannuation
in 1977. He had not. The present Minister thought he had succeeded
in putting superannuation above the political game with the "Guaranteed
Retirement Income. He had not. The previous National government
thought it had done the same with the Accord. It had not.

In fact, the Big Cullen
Fund will continually focus the attention of New Zealanders that
we have not had the debate in 2000/01 that we should have had.
It will be only the latest monument in the superannuation graveyard.
It will remind Generation X and its successors that the baby
boomers have, once again, tried to secure their position at the
expense of everyone else.

The only way that the government
(today and tomorrow) can secure the incomes of tomorrow's retirees
is to grow the economy. That's so tomorrow's larger generation
of pensioners can exchange tomorrow's pensions for things that
allow them to survive. There was not one word in the Minister's
speech about this absolutely key issue. As Nicholas Barr puts
it:

"Given the
deficiencies of storing current production, the only way forward
is through claims on future production. What matters therefore
is the level of output after I have retired. The point is central:
pensioners are not interested in money (i.e., coloured bits of
paper with portraits of national heroes on them) but in consumption
- food, clothing, heating, medical services, seats at football
matches and so on. Money is irrelevant unless the production
is there for pensioners to buy." ("Reforming Pensions: Myths, Truths
and Policy Choices", IMF Working Paper WP/00/139, August
2000.)

In the absence of growth,
the increasing proportion of New Zealanders who aren't producing
(the retired) will make larger proportionate claims on tomorrow's
economy and so must reduce the living standards of the producers
(from what they might otherwise have been). The only alternatives
are for everyone's standards to fall or for pensioners' standards
to fall more than the producers'.

Now, how will the Big Cullen
Fund help us grow? How will it help to resolve the inevitable
inter-generational debate on who gets which part of tomorrow's
economy?

The Big Cullen Fund will
probably be a negative influence
in both of these key areas.

So much for "debunking
super myths".

This is the copy of a speech
Finance Minister Michael Cullen made to Grey Power in Palmerston
North.